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OPEC Deal Triggers Hedging Race In U.S. Shale

The shale oil drillers in the U.S. are hedging their portfolio at breakneck speeds, using the rise in prices to actively hedge their production for 2017, according to banks and consultants, reports Bloomberg. Unfortunately, this may not augur well for OPEC.

"We expect hedge book conversations to tick up during the next round of quarterly calls," Houston-based boutique investment bank Tudor, Pickering, Holt & Co. said in a note to clients on Friday, reports Bloomberg.

After a gap of eight years, and after much haggling, OPEC recently managed to hammer out a deal-to-make-a-deal in Algiers to freeze production.

"OPEC made an exceptional decision today ... After two and a half years, OPEC reached consensus to manage the market," said Iranian Oil Minister Bijan Zanganeh, reports Reuters.

But it looks like instead of creating a balance in the oil markets, OPEC has ended up with the opposite. The sharp rally in crude from the low $40s a barrel to close to $50 a barrel has in fact, invigorated the shale oil industry.

Companies such as Pioneer Natural Resources, which had hedged up to 55 percent of their production for 2017, had plans to increase their hedges by the end of this year. The current spike in oil prices is the perfect platform to do so.

“We are seeing significant producer flows which early estimates suggest could be the highest we have seen all year,” Adam Longson, commodity strategist at Morgan Stanley in New York said in a note to clients, reports Bloomberg.

This hedging not only ensures that the shale oil will continue to flow, it is likely to give the industry a boost, to increase their production levels for the next year.

On a similar note, Chief executive of Pioneer Natural Resources, Scott Sheffield, believes that the U.S. oil production is likely to “flatten” in the first half of 2017 and start growing in the second half of next year, which is likely to reverse the 1.2 million barrels a day of losses since the peak of 2015.

“Shale, even though its short-term, upside potential may be overstated, continues to challenge OPEC in a deep way. The old tool kit doesn’t work very well in this new reality,” said Antoine Halff, former senior official at the International Energy Agency and now a fellow at Columbia University’s Center for Global Energy Policy, reports The Washington Post.

Though improbable, even if OPEC manages to agree on a quota and adhere to it, they will end up reversing the market share gained from the shale oil drillers. At the current juncture, Saudi Arabia cannot afford to lose any revenues from oil whatsoever.

Hence, whether OPEC adheres to a production freeze or otherwise, they are doomed.

“At the end of the day, it just comes down to very, very basic fundamentals: how much oil do you have in the system?” said Joe Tanious, senior investment strategist at Bessemer Trust, reports The Wall Street Journal. And OPEC can no longer control this like they used to.

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Guess they will have a lot of explaining to do to shareholders if they're stuck with hedges way below prompt prices later this year and into 2017. Always a chance of being embarrassed when you overhedge.